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CHAPTER 21
HYBRID FINANCING:
PREFERRED STOCK, WARRANTS, AND CONVERTIBLES

True/False

Easy:

(21.1) Preferred stockAnswer: b EASY
[i].The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.

a.True
b.False

(21.1) Cost of preferred stockAnswer: a EASY
[ii].Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.

a.True
b.False

(21.2) WarrantsAnswer: b EASY
[iii].A warrant is an option, and as such it cannot be used as a "sweetener."

a.True
b.False

(21.2) WarrantsAnswer: b EASY
[iv].A warrant holder is not entitled to vote, but he or she does receive any cash dividends paid on the underlying stock.

a.True
b.False

(21.2) WarrantsAnswer: a EASY
[v].The problem of dilution of stockholders’ earnings never results from the sale of call options, but it can arise if warrants are used.

a.True
b.False

(21.2) Detachable warrantAnswer: a EASY
[vi].A detachable warrant is a warrant that can be detached and traded separately from the bond with which it was issued. Most traded warrants are originally attached to bonds or preferred stocks.

a.True
b.False

(21.3) ConvertiblesAnswer: a EASY
[vii].The owner of a convertible bond owns, in effect, both a bond and a call option.

a.True
b.False

(21.3) ConvertiblesAnswer: b EASY
[viii].A convertible debenture can never sell for more than its conversion value or less than its bond value.

a.True
b.False

(21.3) ConvertiblesAnswer: a EASY
[ix].Most convertible securities are bonds or preferred stocks that, under specified terms and conditions, can be exchanged for common stock at the option of the holder.

a.True
b.False

(21.3) ConvertiblesAnswer: a EASY
[x].Firms generally do not call their convertibles unless the conversion value is greater than the call price.

a.True
b.False

Medium:

(21.1) Preferred stockAnswer: a MEDIUM
[xi].Many preferred stocks extend voting rights to preferred shareholders if the preferred dividend has been omitted for some specified period, for example, 4 quarters.

a.True
b.False

(21.1) Preferred stockAnswer: b MEDIUM
[xii].Preferred stockholders have priority over common stockholders with respect to dividends, because dividends must be paid on preferred stock before they can be paid on common stock. However, preferred and common stockholders normally have equal priority with respect to liquidating proceeds in the event of bankruptcy.

a.True
b.False

(21.1) Preferred stockAnswer: a MEDIUM
[xiii].Preferred stock typically has a par value, and the dividend is often stated as a percentage of par. The par value is also important in the event of liquidation, as the preferred stockholders are generally entitled to receive the par value before anything is given to the common stockholders.

a.True
b.False

(21.1) Preferred stockAnswer: a MEDIUM
[xiv].Preferred stock can provide a financing alternative for some firms when market conditions are such stat they cannot issue either pure debt or common stock at any reasonable cost.

a.True
b.False

(21.1) Floating-rate preferred stockAnswer: a MEDIUM
[xv].Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price, which is desirable for liquidity portfolios, and they also benefit from the 70% tax exemption on preferred dividends received.

a.True
b.False

Multiple Choice: Conceptual

Medium:

(21.1) Preferred stockAnswer: c MEDIUM
[xvi].Which of the following statements is most CORRECT?

a.Preferred stock...
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